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03/21/2010

Greece’s Economic Crisis—Posner

I’ll describe the crisis briefly, then address two questions: whether the nations of the European Union, such as Germany, should try to bail out Greece; and what the Greek crisis tells us about what is in store for the United States.

In the easy-money years of the early 2000s—for which we have Alan Greenspan, other central bankers, and President Bush and his foreign counterparts to thank—the Greek government borrowed a great deal of money from banks, mainly in Europe, to fund its huge public sector. Greece has chronic difficulty in funding its government expenditures out of tax revenues because of rampant tax evasion. And its bureaucracy appears to be either corrupt or incompetent or (probably) both, and as a result its published financial data are inaccurate and misled and continue to mislead lenders. The global downturn, which has driven up unemployment in Greece (to 10 percent) as elsewhere, has weakened the Greek economy further, but what has precipitated the country into de facto bankruptcy is the realization by lenders that Greece, like so many other countries, is dangerously overindebted. Its national debt, most of it owed to foreigners, of some $400 billion is greater than its Gross Domestic Product, and its current annual budget deficit is almost 13 percent of GDP, which means that its indebtedness is growing rapidly. Greece like other borrowers has to roll over its debt continuously. In 2010 it will have to replace some $65 billion in public debt, and fear of default has driven up the interest rate on new Greek government debt to 6 percent.

The Greek government has taken drastic-seeming measures to reduce its deficit. It has imposed new excise taxes and increased existing ones, reduced wages and pensions of government employees and increased their retirement age, and reduced public services. Greece has a huge public sector—40 percent of GDP is generated by the public sector, and 25 percent of Greek workers are public employees—and so the government can effectuate big reductions in public spending virtually by a stroke of the pen, though not without inciting riots.

Despite the measures taken by the government, it is desperately seeking financial aid from EU countries or failing that the International Monetary Fund: that is, it wants to borrow more money, and at lower interest rates than are available from private lenders, in order to avoid defaulting on its public debt or, alternatively, reducing government spending even more sharply than it is doing, with potentially serious political consequences.

Assuming that the Greek government, without foreign assistance, cannot avoid defaulting on its public debt because it has reached the limits of what the Greek people will acccept in the way of austerity measures imposed by their government, there is not much difference between a default on the one hand and borrowing—whether from EU countries or from the IMF on what undoubtedly would be onerous terms—on the other hand. Either way, Greece will be broke. Default would be the cleaner and simpler solution. A cascade effect from a Greek default can be avoided by EU nations’ bailing out any creditors of Greece whose failure, because of a Greek default, would have macroeconomic significance.

Default would be a wake-up call for the Greek nation and put it on the path to competent economic management. A bail out of Greece would be administratively complex. The Greek government would try, for compelling domestic political reasons, to substitute bail out money for cuts in spending and tax increases, and the bailers out, whether EU nations or the IMF, would struggle to prevent the substitution.

Comparisons are being drawn between Greece and the United States. Our national debt of $12.5 trillion is approaching our GDP of about $14.5 trillion and will probably exceed it within the next couple of years, as the debt seems likely to grow by about $1.5 trillion for several years to come, especially with the enactment of the health care bill and the spur that that enactment will impart to other spending programs. Our annual federal budget deficit is now more than 10 percent of GDP. We do not have the same tax-evasion problem as Greece, but we have low taxes and intense resistance to either raising them or reforming the tax system to obtain more revenue with less economic distortion. Our public finances are transparent, so we will not slide into national bankruptcy inadvertently. But we seem incapable either of cutting existing public spending or avoiding costly new public-spending programs.

What we have sustaining us is the status of the U.S. dollar as the major international reserve currency (plus the fact that, since our debt is in dollars, we can reduce it by inflation, though not without cost; Greece can’t do that because it doesn’t have its own currency). Many international transactions are in dollars even when the transacting parties have no American connection. (There are other reserve currencies, mainly the Euro and the Yen, but the U.S. dollar accounts for about two-thirds of the world’s total reserve currency.) If a Saudi Arabian oil company sells oil to Singapore, the sale will be in dollars, and this will require the central bank of Singapore to hold dollar reserves that it can exchange with Singaporean merchants for the local currency to enable those merchants to make purchases in dollars. With the world’s central banks awash with dollars—and for the further reason that many foreign countries, such as China, Japan, Germany, and the oil-producing countries of the Middle East, export much more to the United States than they import from us and as a result accumulate large dollar balances—the United States can easily borrow to finance its public debt. Greece doesn’t have its own currency, and so is in the approximate position of a private borrower.

This happy situation will enable us to avoid defaulting on our enormous public debt for the foreseeable future. But it will perpetuate our fiscal improvidence.